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New Rules on Covered Asset Acquisitions Will Shut Down Transactions to Avoid Sec. 901(m)

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In Notice 2014-44, the IRS announced that
it would issue regulations to prevent taxpayers from
misapplying the statutory disposition rule in cases where the
gain or loss from the disposition of the relevant foreign
asset (RFA) is recognized for U.S. income tax purposes but not
for foreign income tax purposes.

Sec. 901(m)(1)
provides that, in the case of a covered asset acquisition
(CAA), the disqualified portion of any foreign income tax
determined with respect to the income or gain attributable to
RFAs is not taken into account in determining the Sec. 901(a)
foreign tax credit, and in the case of foreign income tax paid
by a Sec. 902 corporation, is not taken into account for
purposes of Sec. 902 or 960. Instead, the disqualified portion
of any foreign income tax is allowed as a deduction. A CAA is
(1) a qualified stock purchase (as defined in Sec. 338
(Section 338 CAA)); (2) any transaction that is treated as an
asset acquisition for U.S. income tax purposes and as the
acquisition of stock of a corporation (or is disregarded) for
purposes of a foreign income tax; (3) any acquisition of an
interest in a partnership that has a Sec. 754 election in
effect (Section 743(b) CAA); and (4) any other similar
transaction the IRS provides.

The IRS said that certain
taxpayers are engaging in transactions shortly after a CAA
occurs that are intended to invoke application of the Sec.
901(m)(3)(B)(ii) statutory disposition rule to avoid Sec.
901(m)’s purpose. In the IRS’s example, USP, a domestic
corporation, wholly owns FSub, a foreign corporation, and FSub
acquires 100% of the FT, a foreign corporation’s stock, in a
Sec. 338 qualified stock purchase. The acquisition of FT’s
stock is a Section 338 CAA, and FT’s assets are RFAs with
respect to that Section 338 CAA. Shortly after the acquisition
of FT in the Section 338 CAA, FT becomes disregarded as an
entity separate from its owner. As a result, FT is deemed,
solely for U.S. tax purposes, to distribute all of its assets
and liabilities to FSub in a deemed liquidation immediately
before the closing of the day before the election is
effective. Under Secs. 332 and 337, no gain or loss is
recognized on the deemed liquidation by either FT or FSub.

The taxpayers have been taking the position that the deemed
liquidation constitutes a disposition of the RFAs under Sec.
901(m)(3)(B)(ii) and that, as a result, all of the basis
difference from the RFAs is allocated to FT’s final tax year
that occurs because of the deemed liquidation, and that no
basis difference is allocated to any later tax year. The IRS
intends to issue regulations to prevent this and similar
practices.

Under these regulations, for purposes of Sec.
901(m), a disposition means an event (e.g., a sale,
abandonment, or mark-to-market event) that results in gain or
loss being recognized with respect to an RFA for purposes of
U.S. income tax or a foreign income tax, or both.

The
portion of a basis difference with respect to an RFA that is
taken into account for a tax year as a result of a disposition
(disposition amount) will be determined pursuant to one of two
rules:

If a disposition is fully taxable (i.e.,
results in all gain or loss, if any, being recognized with
respect to the RFA) for purposes of both U.S. income tax and
a foreign income tax, the disposition amount is equal to the
unallocated basis difference.

If a disposition
is not fully taxable for purposes of both U.S. income tax
and a foreign income tax, generally there will continue to
be a disparity in the U.S. basis and the foreign basis
following the disposition, and it is appropriate for the RFA
to continue to be subject to Sec. 901(m). To the extent that
the disparity in the U.S. basis and the foreign basis is
reduced as a result of the disposition, however, some or all
of the unallocated basis difference should be taken into
account.

The regulations will also include
special rules for a Sec. 743(b) CAA and rules concerning the
continuing application of Sec. 901(m) to the remaining basis
difference.

The regulations described in the notice will
generally apply to dispositions occurring on or after July 21,
2014.

The winner of The Tax Adviser’s 2014 Best Article Award is James M. Greenwell, CPA, MST, a senior tax specialist–partnerships with Phillips 66 in Bartlesville, Okla., for his article, “Partnership Capital Account Revaluations: An In-Depth Look at Sec. 704(c) Allocations.”

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